What Are the Odds of a Recession and How Much Will It Hurt? Your Questions Answered

This story is part of So Money (subscribe here)an online community dedicated to financial empowerment and advice, led by CNET Editor at Large and So Money podcast host Farnoosh Torabi.

What’s happening

A growing chorus of economists and financial experts predict that the US is headed into a recession — defined as two sequential quarters with a significant, pervasive decline in economic activity.

Why it matters

Past recessions have been marked by widespread layoffs, bankruptcies, higher borrowing costs and turbulence in the stock market.

What’s next

No one can predict the future, but it’s vital to remain calm. Gather facts and move deliberately to protect your financial position.

Are we heading toward a recession? A new paper from the Federal Reserve on Tuesday analyzed three economic models to determine the odds of a recession, with mixed conclusions. While two models showed low risk, a broader analysis of inflation and unemployment indicators predicts a rise in jobless numbers over the next year, which could lead to a recession. The report notes that, “historically, elevated inflation and low unemployment have preceded recessions.”

Last week, the Federal Reserve announced the biggest interest rate increase in 28 years, raising rates by 75 basis points, in an attempt to creeping inflation control, which hit a new peak of 8.6% in May. Inflation has remained high throughout 2022 and rising interest rates have already led to more expensive mortgages and higher credit card APRs.

To assess whether we’re in a recession, economic experts have their eyes on gross domestic product, or GDP — the value of all goods and services produced within a country during a specific period — which is a key metric used to gauge economic growth and recessions. In the first three months of 2022, the US GDP dropped by 1.4%. When GDP falls during two quarters back-to-back, technically the country is in a recession. (The National Bureau of Economic Research usually makes the official call, but it hasn’t yet.)

With mounting anxiety about an impending recession in the US, you may be concerned, or at least a little curious, about what this may mean for your finances. My So Money podcast audience recently sent in a number of questions related to recessions — about how best to prepare, save, investing and generally make smart money moves in these uncertain times. Here’s some guidance to help navigate through what is a difficult financial period for many of us.

First, what typically happens in a recession?

It’s always helpful to go back and review recession outcomes so that we can manage expectations. While every recession varies in terms of length, severity and consequences, we tend to see more layoffs during economic downturns. Accessing the market for credit may also become harder and banks could be slower to lend because they’re worried about default rates.

If the Federal Reserve continues to raise rates to clamp down on inflation, then we might see an increase in borrowing costs. So, even if you qualify for a loan or credit card, the interest rate may be higher than it was in the prior year. We’re already seeing this in the mortgage markets where the average rate on a 30-year fixed mortgage is over 5%, the highest level since 2009.

The silver lining in some recessions is that, as rates go up and inflation cools, prices on goods and services fall and our personal savings rates increase, depending, of course, on the labor market and wages. We may also see an uptick in entrepreneurship, as we saw in 2009 with the Great Recession, as the newly unemployed often seek ways to turn a small business idea into reality.

Should I stop investing in my 401(k)?

With stocks in a downward spiral for weeks, many want to know how a recession could impact their long-term investments. should you stop investing? The short answer is: no. At least, not if you can help it. Avoid panicking and cashing out just because you can’t stomach the volatility or watch the down arrows.

My advice is to avoid making knee-jerk reactions. This may be a good time to review your investments to be sure that you’re well-diversified. If you suddenly experience a change in your appetite for risk for whatever reason, talk it through with a financial expert to determine if your portfolio needs adjusting. Some online robo advisor platforms offer client services and can provide guidance.

Historically, it pays to stick with the market. Investors who cashed out their 401(k)s in the Great Recession missed out on a rebound. The S&P 500 has risen nearly 150% since its lows of 2009, adjusted for inflation.

The one caveat is if you desperately need the money you have in the stock market to pay for an emergency expense like a medical bill, and there’s no other way to afford it. In that case, you may want to look into 401(k) loan options. If you decide to borrow against your retirement account, commit to paying it back as soon as possible.

What if I or my partner gets laid off?

In the Great Recession, unemployment reached 10%, and it took an average of eight to nine months for those out of work to secure a new job. So now could be the time to review your emergency fund if you think there’s a shortfall. If you won’t be able to cover a minimum of six to nine months worth of expenses, aim to accelerate your savings by cutting back on spending or generating some extra money.

If you’re self-employed and worried about a possible downturn in your industry or a loss of clients, explore new revenue streams. Aim to bulk your cash reserves, as well. If previous recessions taught us anything, it’s that having cash unlocks choices and leads to more control in a challenging time.

What if the interest rate on my debt jumps or loans become harder to access?

As the Federal Reserve continue to raise interest rates to curb inflation, adjustable interest rates may increase — ratcheting up the APRs of credit cards and loans, and making monthly payments more expensive. Reach out to your lenders and card issuers to learn about low-interest credit options. See if you can refinance or consolidate debts to a single fixed-rate loan.

In past recessions, some banks were hesitant to lend as often as they did in “normal” times. This can be troubling if your business relies on credit to expand, or if you need a mortgage to buy a house. It’s time to pay close attention to your credit score, which is a huge factor in a bank’s decision. The higher your score, the better your chances of qualifying and getting the best rates.

My final note is that it’s important to remember that recessions are a normal part of the economic cycle. Long-term financial plans will always experience some declining periods. Since World War II, the US has had about a dozen recessions and they typically end after a year or sooner. By contrast (and some better news), periods of expansion and growth are more frequent and longer lasting.

Read more: 8 Ways to Recession-Proof Your Finances

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